The last decade has been a mixed blessing for investors in emerging markets. Taken over the whole ten years, to June 2014, emerging markets have comfortably beaten developed markets: the MSCI Emerging Markets index had an annualised total return including reinvested dividends of 12.3%, in US dollar terms, compared with 7.84% for the MSCI World index of developed markets.
But gains in the second half of that period were very disappointing compared to what had gone before. During the last five years, annualised returns of 9.58% for emerging markets lagged a long way behind the 15.62% managed by developed economies. So which half of the decade was normal and what can we expect for emerging markets in the future?
A look at the long term
According to this index, the annualised return from emerging markets between 1900 and 2013 would have been 7.4% in US dollar terms, versus 8.3% for developed markets. In other words, contrary to what most investors believe, developed markets appear to have beaten emerging markets over the very long term.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
This makes the case for investing in emerging markets look very weak. But does it reflect what we can expect from emerging markets in the future? Probably not. Their poor performance largely reflects events in the first half of the 20th century, when revolution and war meant that investors in many emerging economies, such as pre-revolutionary China and Russia, lost everything.
In the more stable conditions that prevailed from 1950 to 2013, emerging markets did rather better, returning 12.5% versus 10.8% for developed markets.
However, as the chart above shows, emerging markets still lagged behind developed marketsin half the decades since 1950. And their outperformance since 2000 was unprecedented by historical standards. This clearly shows the importance of taking a longer-term view and having realistic assumptions about the returns emerging markets are likely to deliver.
Diverging markets
For example, the MSCI Philippines index had an annualised total return of 24.49% in US dollar terms over the last five years, comfortably outperforming both the MSCI Emerging Markets and the MSCI World.
Other southeast Asian markets such as Thailand (19.89%), Malaysia (16.34%) and Indonesia (15.53%) have also seen strong returns. Conversely,other emerging economies such asBrazil (2.47%) and Chile (3.85%) have lagged far behind.
The same is also true at the stock and sector level. Many emerging-market consumer stocks have performed well even while the broader indices have fallen behind.
For example, the MSCI Emerging Market Consumer Staples Index had an annualised return of 17.88%, in US dollar terms, over the past five years. So even during a very weak spell for emerging markets, there have been opportunities to earn good returns.
The importance of value
Indeed, one reason that emerging-market returns sometimes disappoint is that people get carried away by exciting growth stories and end up overpaying for them.
Many investors are surprised to discover that focusing on value is as useful in emerging markets as it is in the developed world. A recent paper by Matthias Hanauer and Martin Linhart, of Technische Universitt Mnchen, found that value stocks outperformed growth ones in emerging markets by an average of 0.93 percentage points per month over the period from 1996 to 2012.
At a country level, Dimson, Marsh and Staunton found that countries with the highest trailing dividend yield outperformed the lowest yielders by 19 percentage points per year on average, over the period from 1976 to 2013.
They also found that investing in countries with the highest growth over the past five years as investors will often do if they give too much weight to the recent past delivered worst returns, whilethose with lower historic growth substantially outperformed.
The good news is that many emerging markets look relatively cheap. The MSCI Emerging Markets index trades on a price/earnings ratio of 13, compared to 18 for the MSCI World. That implies that emerging markets could well be set to outperform developed markets over the medium term. But investors should be aware that the exceptional returns of the early 2000s are unlikely to be repeated.
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
‘Inheritance tax insurance’ enquiries are soaring – but is it worth it?
MPs warn over Lifetime ISAs which could leave savers out of pocket
